Identifying the gaps in the cash conversion cycle is the first step in improving cash flow management. You must strive to optimize your accounts receivable (AR) process, given the potential for different teams’ conflicting priorities in workflows such as credit risk and deduction management. For example, sales want to keep customers happy while finance wants to accelerate cash collection. This requires carefully developed approaches for balancing the trade-offs associated with every decision made across the AR process.
|“According to a U.S. Bank study, 82 percent of business failures are due to poor cash management”|
A business needs to get paid on time to effectively manage its cash flow and plan for short-term investments., This essentially means that the business needs to have a strategic credit and an optimized collections procedure in place.
If the credit team does not assign payment terms based on customer risk profiles, then the collections team will not be able to develop a successful collections strategy to collect the payments. In order to enable your collectors to do their job effectively, you must secure your payments with the appropriate credit policies, bank guarantees, and financial instruments.
An ineffective collections process makes it difficult to track aging accounts receivables and bad debt. It is crucial to track your receivables to optimize cash flow. If there are customers who have not paid their bills, either due to an oversight, miscommunication, or any other reason, that account sits there on the balance sheet getting stale, and the invoices slip from 30 days to 60 days to 90 days past due till they become bad debt. This negatively affects your cash flow and working capital.
With time, an open invoice gets harder to collect. Companies often have hundreds of uncollected accounts in their balance sheet and it is important to get that cash to flow in through the door.
In the next section, we look into the elements that impact collections liquidity.
By now you must have realized that collections liquidity is pivotal to achieve cash flow management goals. Recovering aged receivables isn’t easy, whether one is a business owner, accounts receivable manager, or simply the person in charge of recovering a company’s bad debt. It is not easy to pursue debts, which is why so many companies put off doing so. This leads to weak cash flow and a poor bottom line.
The principal factors affecting collections liquidity are:
Time – The lower your days sales outstanding (DSO), the more liquid your accounts receivables are. Aging accounts are a primary source of worry for any accounts receivable department. Lengthy collection processes also increase DSO. A high DSO indicates that a business sells its goods to the customers on credit and takes longer to collect a payment. This implies a few things, such as—the customer base of the business has credit concerns or that the business has poor collection practices. These shortcomings can affect the overall operational efficiency operation of the business.
Risk profiles – In this competitive climate, every customer is crucial. However, due to the volume of customers and inefficient risk assessment procedures, it is difficult for CFOs and senior finance management leaders to comprehend how customers’ risk profile may affect their operations and cash flow. This limits their capacity to access capital globally and prepare for healthy cash positions in the near future.
Conversion cost – As the business grows, the challenges that it faces as well as the costs also increase. According to recent studies, the value of an uncollected dollar falls to 87 cents in three months, 67 cents in six months, and 46 cents in a year. The lower the cost incurred to collect your due invoices, and the faster you do it, the more liquid your accounts receivables become.
Running a successful company requires you to closely monitor your accounts receivable metrics and KPIs. You must examine the past performance of your company to understand collection efficiency trends. You also need to compare your performance with that of your industry peers to benchmark your performance and share the insights with relevant stakeholders.
Hence, it is crucial to keep an eye on the key performance indicators (KPIs) and other metrics that help track the state of your company’s credit and collections management. Since AR turnover has a huge influence on your cash flow and is crucial to meeting your business’s liquidity needs, you must be at the top of your game to succeed in the modern yet highly competitive market.
Let’s look at some of these metrics that measure the collections liquidity:
Days Sales Outstanding (DSO)
Days Sales Outstanding (or DSO) is the value of receivables outstanding, waiting to be
collected from the customers. The lower the DSO is, the more cash is available for investing in other avenues.
|As per the Credit & Collections Global Benchmarking Study Whitepaper by SUNGUARD, 77% of companies with revenue less than $1 Billion and 87% of companies with revenue greater than $1 Billion adopt DSO as a basic KPI to evaluate the effectiveness and efficiency of their credit and collections process.|
Average Days Delinquent (ADD)
ADD is how many days, on average, the payments are overdue. This can be a warning sign of any cash flow problems. If the number is high, you need to determine whether your systems, collections, and invoice processes need improvement.
|In a 2018 survey by Atradius, business to business (B2B) companies reported that overdue invoices represented 50% of all receivables.|
Accounts Receivable Turnover Ratio (ART)
ART measures how effectively you collect your revenues as an annual broad benchmark. It is determined by taking your net credit sales and dividing them by your average accounts receivable balance. When the ratio is higher, you turn AR into cash more quickly, thus improving your working capital, cash flow, and liquidity. A low ratio can mean it is time to reconsider credit and collection procedures and streamline them with automation tools.
Collections Effectiveness Index (CEI)
Collections Effectiveness Index(CEI) is a popular metric across industries that give cash leaders a better understanding of how their AR teams perform. CEI is defined as “the percentage of account receivables that are collected in a given period.”
CEI provides a clear understanding of the performance of the credit and collections teams. A higher CEI indicates that the organization incorporates a strong credit policy and an effective collections process.
In essence, to fulfill fluctuating liquidity demands and keep up with rapidly changing working capital requirements, a business must prioritize recovering past-due debt as quickly as possible and at the lowest costs.
The volatile economic conditions make it difficult to build an effective accounts receivable mechanism. Your AR strategy needs to continuously evolve to meet the changing economic and technological environment and customer preferences. Incorporating technology into your AR strategy is crucial to create a solid collections process that changes with the climate and trends.
Collections operations can be improved with the help of the right technology.
Incorporating technology is no longer the future of the collections process, but rather the present. Technology tools allow you to access all data, analysis, strategies, correspondence, and information easily.
Two pressing problems that stand in the way of transformation:
Let’s discuss some factors that are crucial to take into account when looking for a solution,
Reduction in human error: Look for workflow automation, preferably a collections tool/platform that automatically prioritizes and assigns collections activities to analysts based on predefined business rules that are unique to your company. This tool should also be able to extend internal and external team collaboration and automate dunning correspondence. All businesses, even those in the same industry, have unique challenges, making it crucial to have a customizable tool for your company.
Centralized data & process visualization: Data centralization and improved task and workflow visualization go hand in hand. The ability to manage promises-to-pay, tasks and reminders for each account not only helps analysts perform more effectively and minimizes errors but also gives AR leaders the ability to take preventive actions proactively.
Ease of implementation: ERP integrations can synchronize workflows and improve collaboration between teams. Therefore, it’s not just important but crucial that one considers a system that is easy to integrate with ERP, accounting software, and other systems to realize the full potential of AR optimization. This reduces the amount of manual input required and the time that it takes for tasks to be completed.
By streamlining the AR process with technology, CFOs can now focus on strategy and planning rather than fire-fighting mistakes caused due to delayed or manual tasks, lack of real-time insights, lack of real-time cooperation, and non-standardized processes.
The ideal collections management solution encompasses all the features discussed in the previous section and provides scalability in terms of the evolving market trends and changing economy. HighRadius Collections Cloud solution provides a complete set of tools to optimize and automate the collections management process. All the information you need like invoices, dispute information, proofs of delivery (PODs), claims, tracking info, etc. on each case is automatically presented in the collections work space and ready to use with a single click.
To learn more about HighRadius collections cloud and how they can benefit your business – talk to our experts today.
HighRadius Collections Software automates and optimizes the credit & collections management process to improve collector efficiency, minimize bad debt write-offs, improve customer relationships, and reduce DSO. It provides a complete set of tools to optimize and automate the credit collections management process and enable the better prioritization of credit collections activities All the information you need (invoices, dispute information, POD, claims, tracking info, etc.) on each case is automatically presented in a collections work-space and is ready for use. Apart from the wide variety of benefits that it has, it also comes with some amazing features like CADE (Collection Agency Data Exchange), collector’s dashboard which has prioritized collections worklist, automated dunning & correspondence, dispute management, centralized tracking of notes, call logs & payment commitments along with cash forecasting functionalities. The result is a more efficient collections team that contributes to enhanced cash flow and reduced DSO.